Real Estate Concepts - October 30, 2023

Value Add Real Estate, Defined

October 30, 2023

Abby Blumenfeld
By Abby Blumenfeld

What is value add real estate investing? Simple put, value add real estate investing is the strategy making aggressive improvements to existing property and capturing returns through improving occupancy rates, increasing average rents, or both. Successful value add investing typically involves exiting at a significantly higher valuation. Hence, value add investors can hope to capture returns both through cash flow and appreciation.

This real estate investing strategy is near the top of the risk/return spectrum. It is more hands-on than the core or core-plus strategies (which may be referred to as “buy and hold”). Hence, value add real estate investments typically pencil out to higher potential risk and, correspondingly, higher potential return. Value add real estate investments are typically less speculative than opportunistic or development strategies, and hence lower potential return / lower risk. 

Passive real estate investors have the option to invest in the full spectrum of commercial real estate offerings and asset types, depending on their individual goals and risk preferences. 

Value Add Real Estate Definition

Real estate investments that entail substantial capital improvements and potentially complex business plans, but do not entail ground-up development. Value add real estate investments entail more risk but higher potential return versus a “buy and hold” strategy.

If you’re curious about investing in value-add real estate, here’s what you need to know: 

Listen to this article on value add real estate investing

What is Value Add Real Estate?

Value add real estate assets typically have existing income, but require some improvements to provide attractive returns. In their current state, they may be a bit run-down, or poorly managed. But operators who acquire these properties see their potential. With a few upgrades, operators are able to attract higher-quality tenants, charge more rent, and increase their property’s net operating income (NOI). Real estate developers and sponsors who are experienced at investing in value add real estate can see a through-line to both appreciation and income, drawing up precise business plans to deliver value to both co-investors and tenants. 

In many cases, a value add real estate investment strategy would involve the following phases:

  • Acquisition of an under-appreciated asset an attractive going-in basis.
  • Value-add improvements, such as new appliances; new HVAC systems; updated windows; improved common areas; enhanced landscaping and curb appeal; on-site services like gyms, pools, or daycare.
  • A repositioning of the property, perhaps including a renaming or rebranding of the property.
  • Bringing rents to market and/or carrying out a lease-up plan to get closer to 100% occupancy, improving NOI of the asset.

You’ll notice that these examples are pertinent mostly to multifamily investing.

However, value add real estate investing can apply to other asset classes in specialized form. Industrial value add real estate investment may entail improving security systems and increasing operating heights, for example.

Value add real estate investing is complex and capital-intensive. In the fintech-enabled investing era, however, you may be able to access value add real estate opportunities passively and fractionally via a platform like EquityMultiple. 

How Risky is Value Add Real Estate?

Value add real estate assets can be found in the upper-mid portion of the real estate risk spectrum, providing moderate to high risk for moderate to high returns (see below). Both the risk and return potential is largely due to the nature of the renovations required. Curing deferred maintenance, for instance, can be expensive and time-consuming. On the other hand, performing this maintenance can significantly increase the property’s value, making it a worthwhile endeavor. 

Risk Spectrum Graphic depicting the return potential and risk of principal loss for Core, CorePlus, Value Add, and Opportunistic real estate investments

If this level of risk does not seem right for your current strategy, consider these other asset types: 

  • Core Real Estate: At the low end of the risk spectrum, core properties are typically located in Tier I or Tier II markets with high demand. The assets are in good condition, and are leased to quality tenants. Investors often employ a “buy and hold” strategy. 

  • Core-Plus Real Estate: Similar to core real estate, these properties are often in desirable markets, but involve slightly higher risk. For instance, the property could benefit from minor renovations, or it may not be fully leased. 

  • Opportunistic Real Estate: As the name implies, opportunistic real estate investing entails the highest risk, along with the highest potential returns. Investors should note they may need to hold these assets for quite some time, as operators build a project from the ground up, or perform significant rehabilitation.  

Passive investors who demonstrate interest in value-add real estate should consider whether Sponsors have prior experience executing on business plans that entail potentially complex renovations or capital improvements. Value-add projects involve more uncertainty and generally longer hold periods before a target exit than core or core-plus investments. Hence, the range of possible IRRs on a realized value-add project is generally greater than for more conservative strategies. 

That said, EquityMultiple’s Real Estate Team does significant diligence to ensure that Sponsors have a strong business plan. Stress testing sponsor assumptions and considering a range of outcomes becomes all the more critical with value-add investments—you can expect to find this scenario analysis in our diligence items. Our Asset Management Team then monitors assets from close through exit, seeking to maximize investor returns and mitigate risk. 

Stages of Value Add Projects

Value add real estate investing targets properties that exhibit existing income but require enhancements to realize their full potential. These improvements can range from physical renovations to operational efficiencies, all aimed at increasing the property’s net operating income (NOI) and, consequently, its value.

Investors in value add properties typically follow a multi-phase approach:

  1. Acquisition: Identifying and purchasing an underperforming asset at an attractive price. For example, an investor may find a residential complex with high vacancy rates due to outdated interiors and lack of amenities. The purchase price reflects these issues, providing a lower entry point for the investor.
  2. Improvement: Implementing value-add improvements such as modernizing units, enhancing amenities, and optimizing property management. This could involve renovating kitchens and bathrooms, adding a fitness center, or implementing a new property management system to improve tenant satisfaction and retention.
  3. Repositioning: Rebranding the property and adjusting rental rates to reflect the upgraded status. After improvements, the property may be marketed as a premium living space, justifying higher rents and attracting a new demographic of tenants.
  4. Stabilization: Achieving higher occupancy rates and operational efficiency to improve NOI. The focus here is on maintaining high occupancy through competitive pricing and excellent customer service, leading to a steady stream of rental income.
  5. Disposition: Selling the property at a higher value, reflecting the improvements and increased income. The end goal is to sell the property for a profit, capitalizing on the increased value due to the strategic improvements made.

Finding the Right Value Add Investment Property 

Focusing on the right market to carry out value add real estate investing is the “top-down” component of the strategy, but the “bottom-up” component, is equally critical: performing property-level screening and discerning acquisition opportunity on an asset-by-asset basis. Firms can screen opportunities by looking for undervalued, underperforming assets in areas they deem attractive. Based on the investor’s preferences and real estate expertise, each investor can also factor the property’s size, age, layout, amenities, and location into consideration.

Selecting the right value-add acquisition opportunity is by no means picking low hanging fruit. While many properties can qualify for this strategy purely based on the value or condition, some properties can be too expensive to repair or functionally obsolete. What appears as a “deep-value” opportunity can easily be a “value trap” in disguise. 

The tradeoff is potential income versus renovation risk. Typical Class-A buildings in a city center, though well maintained and stable, typically offer little room for rent increases. These newly completed assets are also more vulnerable to new construction, directly competing with new supply coming into the market, which can make maintaining occupancy and rent increases an uphill battle especially in a trending, over-supplied market. In contrast, Class-Cs charge below-market rent but with lower tenant turn over, investor’s ability to increase the rent is limited by potential tenants’ willingness to pay. Considering the main discount factors on these Class-C multifamily buildings are invariable property characteristics such as layout and location. Apartment renovations alone will not be conducive to attracting a new group of tenants who are willing to pay high enough rent that can justify the renovation cost. 

Value add real estate investors can strike a balance between cost and value potential with Class-B assets. Cap rates for Class-B value add real estate investments are more attractive than those of core, Class-A assets. Class-B assets offer more inherent room to raise rents and reduce operating expenses in comparison to Class-A assets. Hence, Class-B assets are less dependent on cap rate compression. By revamping each unit, common area, and the property exteriors, Class-B multifamily investors can offer tenants high-quality housing options without costing Class-A rent, justifying rent increases and drawing potential tenant demand from those who are seeking high-quality housing without breaking the bank.

Class AClass BClass C
Cap ratesLowHigherHighest
AgeLess than 10 years10-40 years30 + years
RentHigh, little room for growthIn between, potential room for growthLow, below market
TenantMid to high incomeMiddle-classBlue-collar, workforce housing
MaintenanceWell maintained, newestReasonably well-maintainedNeeds improvement
LayoutMost current and upscaleReasonably up-to-dateObsolete


After preliminary screening and identifying acquisition targets, it is critical that the sponsor performs thorough due-diligence and gain a solid understanding of a property’s physical condition. Undiscovered structural flaws and other hidden issues can lead the project astray from the original underwriting and jeopardize the predetermined budget. In order to avoid exposing the investors to cost overrun and delaying the stabilization, the sponsor must preemptively remove any surprise and account for any renovation challenges upfront in the underwriting prior to acquisition.

“Value-Add Real Estate remains ideally positioned in the current macro environment. Defensively, its in-place cash flow and enhanced unlevered return profile continues to drive accretive opportunities in the current high-rate environment. Opportunistically, amidst several market challenges, identifying and repositioning viable properties to unlock Alpha, to then capitalize on when the market returns can be key to realizing superior risk-adjusted returns.”

— Charles de Andrade, CAIA | Director of Capital Markets, EquityMultiple

 

This is the part of value-add investing where manager selection is most critical. Passive investors must carefully select investments based on the sponsor’s real estate experience and track record. At EquityMultiple, we  partner with experienced sponsors and perform our own underwriting on behalf of investors. We perform in-house sponsor-level and transaction-level due diligence to provide another layer of protection to investors seeking to harvest the benefit of value add real estate investing opportunities.

Value-Add Real Estate Examples

Exterior of a Value-Add Real Estate Investment in Raleigh, NC
Exterior of a Value-Add Real Estate Investment in Raleigh, NC
Wondering what value-add real estate entails, and if the strategy is worthwhile? Here are a few examples from prior EquityMultiple investments: 

Property 1: Interior Upgrades

In this case, the Sponsor’s goal was to add value by upgrading individual units within this property. The newly renovated units featured new cabinets, granite countertops, stainless steel appliances. The Sponsor also installed new high-end lighting and plumbing fixtures, backsplash tiling, washer-dryers, dishwashers, and hardwood flooring. 

Property 2: Common Area Improvements

At the time of investment, rents at this property were below market. The Sponsor identified an opportunity to renovate the property’s common spaces, upgrading amenities and deferred maintenance that included a new pool deck and club house, new outdoor kitchen, fitness center, dog park, and significant landscaping upgrades.

Now, let’s do the math. We’ll say this operator acquired the property for $100,000 per unit. Each unit rented for about $800, approximately 15% below market comparables. Upon renovation of 100% of the units, at a cost of $15,000 per unit, they can increase rents by 40%— directly in line with market comps for similarly renovated properties. After a 4-year target hold, which includes a 3-year renovation and lease-up period, they plan to sell the property at a projected 6% cap rate. Sounds pretty good, right? 

Of course, the main benefit of making these improvements is the impact on the property’s NOI. Operators can often acquire a mismanaged property at an attractive cost basis, and then sell it for high returns later once the new value is evident.

Besides physical renovations, value add real estate investors should not sleep on operational enhancement opportunities. Adjustments to property management can drive some of the quickest improvements in net operating income. Investors can ensure a sound business plan by parlaying interior and exterior upgrades with improved services for residents, tenant communication, and marketing efforts. Starting from top-line revenue, experienced property management can augment the value-add investment plan by making impacts on each line of the income statement. Property management maximizes rent yields via tenant management and analytics, attracts high-quality tenants, and minimizes the loss from long vacancies, smoothing the top-line revenue as the value-add property transitions from the renovation phase to the stabilization phase. 

The Bottom Line

For many passive real estate investors, the benefits of value-add properties are clear. There is more risk associated with this asset type than a core or core-plus investment; however, the potential returns can be hard to pass up. Each individual investor must decide for themselves whether a project’s returns are appealing relative to the risks. This can depend on a number of factors, including:

  • Cap rate movement
  • Sponsor experience
  • Current rents vs. market rents
  • Market fundamentals

When evaluating a potential investment, pay close attention to the Sponsor’s business plan. Experienced operators should clearly outline why a property is slightly neglected or undervalued, as well as how they can increase its NOI.

 


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FAQs on Value Add Real Estate Investing

What is the typical hold period for a value add real estate investment?

The hold period for a value add investment can vary but typically ranges from 3 to 7 years, depending on the complexity of the improvements and the market conditions. During this time, sponsors are actively involved in the management and oversight of the property’s improvement plan. EquityMultiple’s Asset Management Team is highly engaged throughout the lifecycle of any value add project.

How does EquityMultiple select value-add investment opportunities?

EquityMultiple conducts thorough due diligence, including sponsor vetting, market analysis, and financial modeling, to select investment opportunities that meet our criteria for risk-adjusted returns. We also consider the potential for community impact and sustainable practices in our investment selection process.

Can value-add investments protect against market downturns?

While value-add investments carry inherent risks, strategic improvements can make properties more competitive and resilient in various market conditions. However, no investment strategy is entirely immune to market downturns. Value-add investments can offer a buffer through increased operational efficiency and the potential for higher rental income.

What types of properties are suitable for value-add strategies?

Properties that are suitable for value-add strategies typically have operational inefficiencies, deferred maintenance, or outdated features that, once addressed, can enhance the asset’s appeal and income potential. Examples include older apartment complexes in prime locations, commercial buildings with below-market rents, or properties with high tenant turnover due to poor management.

How can I participate in value-add real estate investments with EquityMultiple?

Accredited investors can join EquityMultiple to gain access to a curated selection of value-add real estate investment opportunities. Our platform provides detailed information and support to help investors make informed decisions. We offer a range of investment structures, including direct equity, preferred equity, and debt, to suit different investor profiles and objectives.

Investing in value-add real estate can be a powerful strategy for those looking to enhance their investment portfolios. With the right approach and expertise, investors can unlock the hidden potential of underperforming properties and achieve substantial returns. At EquityMultiple, we’re committed to providing our investors with access to high-quality value-add opportunities that reflect our high standards for due diligence and potential for growth.

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Abby Blumenfeld
Abby Blumenfeld
Abby Blumenfeld is the Senior Investor Relations Analyst at EquityMultiple. Originally from Massachusetts and a graduate of Quinnipiac University, Abby has an extensive background in both commercial and residential real estate. Before joining EquityMultiple, she gained experience working with commercial properties at Cushman and Wakefield. Her experience includes both the New York City and Boston real estate markets. At EquityMultiple, Abby is responsible for developing relationships with prospective investors, ensuring clear communication, and serving as the primary point of contact for investors. If you reach out to EquityMultiple, there’s a good chance you’ll interact with Abby during your journey. Outside of work, Abby enjoys playing pickleball, tennis, and traveling.

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